Limiting the 401(k) Finder’s Fee


General

Fred Reish was quoted in a New York Times article on June 21. The article, titled, “Limiting the 401(k) Finder’s Fee” takes a look into the fees behind employee’s 401(k)’s as they begin to replace pensions.

A series of lawsuits are making their way through the courts, which have raised questions about whether employees are being overcharged for their accounts. The lawsuits and new federal rules have helped bring fees down to a more reasonable level. While some employers have begun to adopt arrangements with less fees that more clearly separates what they are paying for, fees that workers pay can still vary widely and be hard to recognize or understand.

“It’s unfortunate that it took litigation to focus attention on costs, but it has,” said Fred.

The link to the article can be found on the Drinker Biddle website, here.

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Managing Plan Costs


404a-5, DOL, fiduciary, plan sponsors, recordkeeper, registered investment advisers, service providers

Many recordkeepers and bundled providers charge plans based on the number of participant accounts. Many others do not explicitly charge on a per-participant basis, but incorporate the number of accounts (and possibly the average account balances) into their pricing. It is likely that this practice will increase in the future . . . due to the new 404a-5 participant disclosures, which must be made to every eligible employee, as well as to every participant of an account balance.

With that in mind, advisers, recordkeepers and plan sponsors should consider mandatory distributions of small account balances (that is, $5,000 or less) to manage plan costs.

If a plan has the required provisions, and if the provisions have been appropriately communicated to eligible employees and beneficiaries through summary plan descriptions, plans can make distributions of account balances of $5,000 or less. If the participants don’t take those distributions, then the plans can directly roll the money over into IRAs for them. In either case, the effect of the mandatory distributions will be to improve the pricing for the plan . . . either because it reduces the number of accounts or, alternatively, because it increases the average account balance (due to the elimination of small accounts).

As you might expect, both the IRS and the DOL have issued guidance on how to do that. The combined effect of the guidance is that plan fiduciaries essentially have a safe harbor for making mandatory distributions of small accounts . . . if they follow the rules. Unfortunately, there are too many requirements for a short email like this. However, my partner, Bruce Ashton, and I have written a white paper that describes the requirements.

In writing that white paper, we took an approach that I think will be helpful to advisers and plan sponsors. The body of the white paper is a discussion of the benefits of mandatory distributions . . . in terms of plan pricing. Then, there are three appendices: the first two discuss the IRS and DOL guidance, respectively; and the third one covers adviser compensation related to a mandatory rollover program.

If this subject is interesting to you, you may want to look at the Inspira white paper. It is located at http://www.drinkerbiddle.com/resources/publications/2013/mandatory-distributions-white-paper?Section=Publications.

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Fiduciary Obligation to Select Appropriate Share Classes


fiduciary, plan sponsors, prudent

I imagine that, by now, you have heard about the Court of Appeals decision in Tibble v. Edison. While the court decided a number of issues, the most important one is that fiduciaries have an obligation to select appropriate share classes for their plans. Closely related to that is the trial court’s admonition that fiduciaries must ask about the available share classes.

ERISA imposes both a fiduciary rule and a prohibition on spending more than reasonable amounts for operating a plan, including the investment costs. The Tibble decision was about the reasonable expense ratios for plan investments. However, rather than looking at the evaluation of mutual fund expenses in the traditional way (that is, comparing expense ratios to those of other funds), the trial court found, and the appellate court agreed, that plans must use their purchasing power to select the appropriate share class. The practical consequence is that advisers should make recommendations based on the share classes available and must educate plan sponsors about the available share classes, including their costs, and plan sponsors (typically acting through their plan committees) must understand that multiple share classes may be available and must investigate which are best for their plan and participants.

That could be a daunting task. Just consider that some mutual funds may have 10 or more share classes. That could include, for example, A, B, C, I, R-1, R-2 shares, and so on. This will place an additional burden on advisers . . . and, in that sense, may favor advisers who focus on retirement plans.

But, it is more complicated than that. Share classes for mutual funds and separate account “classes” for group annuity contracts may, for these purposes, be virtually identical. If that is true, advisers will need to educate plan sponsors on the classes available in group annuity contracts. Then, advisers will need to help plan sponsors select the appropriate separate account class for that particular plan. Since some insurance companies offer group annuity contracts with 10 or even 15 separate account classes, advisers will need to be more attentive to the alternatives that are available and will need to work with plan sponsors to understand the share and separate account classes (including the revenue sharing and compensation aspects) and to select the appropriate classes based on the size and needs of the particular plan.

In the future, we could see litigation where advisers did not educate plan sponsors on the availability of alternative classes and do not make appropriate recommendations.

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GAO Report on IRA Rollovers


General

Periodically I will be posting information or materials from external resources, such as government agencies, that I think will be useful. This is the first of those posts. These materials will be linked on the blog to the “External Resources” page of the blog.

The GAO just issued a report on IRA rollovers. The title is: “401(k) PLANS: Labor and IRS Could Improve the Rollover Process for Participants.” You can find a copy of the 71-page report here.

While the GAO Report recommends a number of changes to improve the rollover process and experience for participants, it is remarkable for the comments that it makes about the IRA rollover services of some providers. For example, at one point, it states: “Plan participants are often subject to biased information and aggressive marketing of IRAs when seeking assistance and information regarding what to do with their 401(k) plan savings when they separate or have separated from employment with the plan sponsor. In many cases, such information and marketing comes from plan service providers.” Look at the portion of the linked report beginning on page 22.

Based on this report and on the response by the DOL, it seems almost certain that the fiduciary advice proposal (that is due in July 2013) will contain provisions that further regulate the IRA rollover process.

Fred Reish (fred.reish@dbr.com)

 

 

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Fiduciary Advice and 12b-1 Fees


broker-dealers, DOL, fiduciary, prohibited transaction, registered investment advisers, service providers

The DOL recently settled a case for $1,265,608.70 with a firm that provided investment advice to retirement plans. Based on the DOL’s press release, the firm served as a fiduciary investment adviser to ERISA plans and recommended investments in mutual funds. In addition to the firm’s advisory fee, it also received 12b-1 fees.

Based on the press release, it appears that the DOL asserted two claims. The first is that the receipt of additional fees (which could include both 12b-1 fees and some forms of revenue sharing) is a violation of the prohibited transaction rules in section 406(b) of ERISA.

The second theory appears to be that, where a fiduciary adviser receives undisclosed compensation, the adviser has, in effect, set its own compensation (to the extent of the undisclosed payments). In the past, the DOL has successfully taken the position that, by receiving undisclosed compensation, a service provider has become the fiduciary for the purpose of setting its own compensation and has used its fiduciary status for its own benefit.

In any event, RIAs and broker-dealers need to be particularly conscious of undisclosed payments and/or payments in addition to an advisory fee. In recent years, the DOL has gained a greater understanding of RIA and broker-dealer compensation and is actively investigating both.

I have reviewed the 408(b)(2) disclosures of a number of broker-dealers. In a few cases, the broker-dealers specifically state that, where they were serving as fiduciary advisers, they were also receiving additional compensation (e.g., revenue sharing). Those disclosures raise issues about prohibited transactions.

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The Benefits of Mandatory Distributions: A White Paper


plan sponsors

Small 401(k) accounts of former employees increase plan costs, expand administrative obligations and extend fiduciary responsibilities. Plan sponsors should consider distributing these accounts under a well-defined process and regulatory safe harbors, and advisers can provide a valuable service to their clients by educating them on the benefits of mandatory distributions and helping them set up a routine process for sweeping out small accounts. By small accounts, we mean accounts of former employees with vested balances of $5,000 or less. (In determining whether an account falls under the $5,000 limit, amounts rolled over from a prior plan or IRA and earnings on those amounts are not considered. Thus, an account may have a larger total balance and still be considered a “small account” for purposes of this concepts discussed in this White Paper.)

This White Paper discusses the reasons for – and benefits of – making mandatory distributions on a regular basis and the regulatory guidance related to these distributions under the Internal Revenue Code (Code) and the Employee Retirement Income Security Act of 1974 (ERISA). We also address whether financial advisers may be compensated in connection with such distributions. In the Discussion and Analysis section of this White Paper, we summarize the issues and rules and discuss services that can assist plan sponsors and advisers in handling mandatory distributions. In the three Appendices, we describe the regulatory guidance in greater detail – for those who want a deeper understanding of the legal underpinnings for our conclusions.

To see the full text of this White Paper, click here:

The Benefits of Mandatory Distributions A White-Paper-February-2013

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Anticipated DOL Guidance


408(b)(2), DOL, fiduciary, plan sponsors, service providers

The Department of Labor recently issued its agenda for regulatory guidance. Several of the projects will impact retirement plans and particularly 401(k) plans. This email focuses on a DOL project to amend the 408(b)(2) regulation to possibly require that cover service providers furnish a “guide” or similar tool, along with the disclosures. In its description of the project, the DOL states: “A guide or similar requirement may assist fiduciaries, especially fiduciaries to small and medium-sized plans, in identifying and understanding the potentially complex disclosure documents that are provided to them or if the disclosures are located in multiple documents.”

As background, the final 408(b)(2) regulation contain a sample guide. Covered service providers may want to review that part of the regulatory package in order to understand the DOL’s approach. Briefly described, though, that guide would require that, for each mandated disclosure, a covered service provider indicate the section number and page number where the particular disclosure was made. They might be viewed as a one or two page index of exactly where the required information was located. In other words, it is not a summary, but instead a “map.”

It appears that the DOL is concerned that—by using multiple disclosure documents or lengthy or complex documents—service providers may have presented the disclosures in a manner that is difficult for plan sponsors to understand. While the guide would likely benefit plan sponsors, it can impose a significant burden on providers who have used multiple documents and/or lengthy documents to make their disclosures. That would be particularly true where the paragraph numbers and/or page numbers can change from plan to plan. That would also be difficult for covered service providers who refer to other documents, such as a mutual fund prospectuses.

Unfortunately, the DOL description of the project does not indicate whether the requirement will be applied only prospectively or whether it would apply retroactively. If I had to guess, it would be that the DOL would make the application prospective…simply because of the cost and burden of the “re-disclosing” to existing plans.

In any event, the guidance will be issued in proposed form and there will be a comment period. At this point, the DOL has indicated that it is targeting a May date for release.

 

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Plans With Only Brokerage Accounts


404a-5, DOL, fiduciary, General

On July 30, the DOL reissued its Field Assistant Bulletin (FAB) concerning participant disclosures. The FAB was reissued because of the controversy about the DOL’s position on individual brokerage accounts.

The new FAB deletes the old, and controversial, Q&A 30 and replaces it with a new Q&A 39.

While some of the controversial provisions were removed, some remain. For example, the DOL states:

“…in the case of a 401(k) or other individual account plan covered under the regulation, a plan fiduciary’s failure to designate investment alternatives, for example, to avoid investment disclosures under the regulation, raising questions under ERISA section 404(a)’s general statutory fiduciary duties of prudence and loyalty.”

Continue reading Plans With Only Brokerage Accounts →

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Brokerage Windows and Retirement Plans


DOL, fiduciary

When the Department of Labor issued Field Assistant Bulletin (FAB) 2012-02, the private sector was “shocked” by the DOL’s position on fiduciary responsibilities for brokerage windows in defined contribution plans, such as 401(k) plans. The Department subsequently partially reversed part of its guidance. However, significant portions of that guidance remain, and it continues to be a DOL position that plan sponsors have fiduciary responsibilities for brokerage windows in retirement plans.

My partner, Bruce Ashton, and I recently wrote an article about brokerage windows for TD Ameritrade. As explained in the introduction to the article:

“The first topic of this article, and its principal focus, is the fiduciary process for deciding whether to offer a brokerage window and selecting the provider of the window. The second covers the requirements under the new participant disclosure rules. Finally, we consider the implications of the fiduciaries or a participant selecting an RIA to serve as an investment manager or advisor for a participant’s individual brokerage window.” Continue reading Brokerage Windows and Retirement Plans →

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